Name: KEY
ECON 202—Montgomery College
EXAM 01

There are 110 possible points on this exam. The test is out of 100.

You have one hour and fifteen minutes to complete this exam, but you should be
able to complete it in less than that

Please turn off all cell phones and other electronic equipment.

You are allowed a calculator for the exam. This calculator cannot be capable of
storing equations. This calculator cannot double as a cell phone.

Be sure to read all instructions and questions carefully.

Remember to show all your work.

Recall basic logic. “Water is wet” is a true statement. “Water is wet and leopards
have stripes” is a false statement.

Please print clearly and neatly.
Part I: Multiple Choice. Choose the best answer to the following.
4 points each.
1. The Broken Window Fallacy concerns the tendency for people to:
a. Break windows
b. Ignore opportunity cost
c. Refuse to trade
d. B & C
e. None of the above
By applauding the metaphorical breaking of windows, people ignore that
resources spent on replacing them could have been used to get something
else while maintaining the enjoyment of the window.
2. People engage in an activity until:
a. Marginal benefit equals marginal cost
b. Marginal benefit equals marginal profit
c. Marginal benefit equals opportunity cost
d. A & B
e. None of the above
People think on the margin, continuously weighing the costs and benefits.
3. Buying a book at $8 when you would have paid $10 creates:
a. Consumer surplus
b. Producer surplus
c. Equilibrium
d. A & C
e. None of the above
Recall that consumer surplus is the area below the demand curve but above
the price.
4. Which of the following explains why a college degree increases earning
potential?
a. A college education signals you are friendly and sociable
b. A college education increases your productivity
c. A college education demonstrates that you are a hard worker
d. B & C
e. None of the above
Your social skills do not inherently help you get a degree so you cannot
claim that it signals friendliness. The other options are human capital and
signaling, respectively.
5. In October 2011, musician JD Samson published a commentary in the Huffington
Post called “I Love My Job, But It Made Me Poorer.” She wrote about the
paradox that though she’s a workaholic, she couldn’t make a decent living as a
musician. Samson proposes three possible reasons for her poverty:
…1) my family is not rich, 2) I am a queer woman, and 3) I am trying so
desperately to keep up with my peers that I am living beyond my means…
Based on the information provided, which of the following ideas would help her
understand a possible 4th reason?
a. Increasing marginal costs
b. Opportunity costs
c. Compensating differentials
d. The Law of Supply
e. None of the above
If a job is inherently fun—as many find being a musician—there will be
many people who want to do it. This increased supply means a movement
along the demand curve: more quantity means a lower wage. In other
words, compensating differentials.
6. Suppose the first worker hired for a factory has a marginal productivity of labor of
$32. If each additional worker’s marginal productivity of half the previous worker
(2nd has $16, 3rd has $8, etc) and the current wage is $2, how many workers
should be hired?
a. 2
b. 3
c. 4
d. 5
e. None of the above.
The 4th will add $4 and the 5th will add $2. That’s where MC=MB.
7. The demand for shoes would shift to the right if:
a. A shoe factory was destroyed.
b. Tennis became more popular.
c. Gasoline prices continued to climb.
d. B & C
e. None of the above.
Answer (a) is about the supply shifting to the left. But (b) and (c) represent
changes in complements (b) and substitutes (c).
8. This graph illustrates the work of psychologists Harvey Whitehouse and Quentin
Atkinson, as published in the April 23-29 2011 issue of The Economist. The
“unpleasantness” of religious rituals (0 is low, 5 is high) is along the x-axis. How
often the religion requires the ritual to be
preformed is along the y-axis. What economic
concept does this diagram represent?
a. Opportunity cost
b. Consumer surplus
c. A demand curve
d. A & C
e. None of the above
Another way to think of “unpleasantness” is
“price” and another way to think of “frequency” is “quantity.” Thus you
get a predictable downward sloping demand curve (though the axes are
reversed).
9. In Bastiat’s “That Which Is Seen, and That Which Is Not Seen,” how does Bastiat
describe opportunity cost?
a. That which is seen
b. That which is not seen
c. A broken window
d. A & C
e. None of the above
What is seen is the activity that happens because of destruction. What is not
seen is the activity (and subsequent wealth) that would happened had the
destruction never occurred. The broken window isn’t the opportunity cost;
that’s the act
10. Billy Vales works for the city as a sewage cleaner. His job involves scrubbing the
passageways beneath city streets to free it from rats, hardened human and animal
excrement, and rotting trash that sometimes clog the sewer system. Billy gets paid
a very high salary, well above what most his friends with similar education levels
as him. He loves his job—Billy enjoys the idea he’s clearing the way so the
machinery of the city can function. He also had an accident as a child which
resulted in the loss of his sense of smell. Does this example contradict the idea of
compensating differentials?
a. No, because Billy is an exception—most people wouldn’t enjoy his job
b. No, because compensating differentials predict people with jobs they
enjoy will be paid more because a happy worker is a productive worker
c. Yes, because Billy enjoys his job but he’s paid very well; enjoyable jobs
should be paid less
d. Yes, because the supply of labor should shift up but Billy is evidence that
it shifted down
e. None of the above / It is impossible to tell with the information provided
Billy not only seems to enjoy working with trash and feces, which is unusual,
but his childhood accident renders him immune to this job’s biggest
drawback. Most people are not in Billy’s position: their preferences and
functioning senses render them relatively unwilling to be a sewage cleaner.
This lack of interest puts upward pressure on wages and, as predicted by
compensating differentials, cause the wage of sewage cleaners to increase (a
wage which Billy enjoys).
This points to an important lesson of compensating differentials: seek out
employment in areas where your unpopular preferences or circumstances
are an asset. If you enjoy the smell of sulfur, work in a place where sulfur is
common. If you enjoy living away from civilization and modern
conveniences, look into becoming a forest ranger. If you love to live on the
edge and flirt with death, work as a roofer (one of the most dangerous jobs
in the United States).
11. Which of the following is not a requirement of perfect competition?
a. Many people are buying and selling
b. New buyers and sellers may enter the market and existing participants are
free to leave
c. Buyers and sellers know all the relevant information about the good in
question
d. A & B
e. None of the above
All of these are requirements: (a) is that there’s a large number of buyers
and sellers, (b) is the requirement of freedom of entry and exit and (c) is
another way of saying perfect information.
12. In 2011, the U.S. Senate voted to end ethanol subsidies. If the bill passed, what
happens in the market for corn? (Ethanol is made from corn.)
a. The demand curve will shift, causing the price of corn to rise.
b. The supply curve will shift, causing the price of corn to rise.
c. The supply curve will shift, causing the price of corn to fall.
d. B & C
e. None of the above
Ending subsidies cause fewer firms to want corn to turn into ethanol
(because now ethanol is more expensive to make). Thus the demand curve
will shift down, causing the price of corn to fall.
Part II: True/False. Answer true or false and justify your answer.
10 points each.
13. In an efficient market, producer surplus plus consumer surplus equals the area
between the supply and demand curves and only when demand is greater than
supply.
True. Recall that producer surplus is Price – Supply and consumer surplus
is Demand – Price. Both combined are Demand – Supply, but only when
Demand > Supply (when the reverse is true, efficient markets do not
consume there).
14. If this class was famously difficult, some of you would be better off.
True. Some of you (those who did well) would be able to use their success in
this class as a signal to potential employers that they are smart and hardworking. They will be able to demand a higher wage (much like the
justification for why college degrees translates into a higher wage).
15. Suppose President Obama announces that the US will be arming and training a
large group of ninjas, requiring the government to purchase many ninja stars. In
the market for ninja stars, this will cause the supply curve to shift and the price of
ninja stars to increase.
False. While the price will increase, the demand—not the supply—will shift
and it will to the right. The price will increase and the quantity will increase.
Part III: Short Answer. Answer the following.
16 points each.
16. Suppose a tornado destroys a farmhouse. The family has no insurance and
collectively values the house at $250,000. It costs $100,000—money that was
sitting in their child’s college fund—to fix the house. Finally, suppose the family
collectively values sending the child to college at $200,000. Calculate the
economic profit of having a tornado destroy the house. Remember to show your
work.
Tornado disaster:
(250,000 – 100,000) – (250,000 + 200,000 – 100,000) = -200,000
Note the family loses out on their opportunity cost: sending their child to
college.
17. Using a complete and fully labeled diagram, illustrate the effects of the following
(4 points each). Remember: do not shift more than one curve.
a. The local roofing market after a hurricane hits a city.
b. The market for computers after the microchip was invented.
c. The market for bread after the price of pastrami falls.
d. The market for bread after the price of bagels fall.
A
C
B
D